Direct listings—something new, or variations on a theme?

There has been a lot of publicity and interest surrounding the direct listings of Spotify (2018) and Slack (2019) in the United States. In many respects, these transactions resemble the traditional "introduction" which has been utilised in the UK for many years for a number of purposes. What sets the new model of direct listing apart, is it something which could be attractive for issuers seeking to list in London, and if so, how could the structure be implemented?

What sets the direct listings of Spotify and Slack apart from other listing transactions?

The new model of direct listing as utilised by Spotify (2018) and Slack (2019) in the United States represents a specialised form of introduction which was developed to address specific considerations that distinguish it from a traditional underwritten initial public offering ("IPO"):

• Liquidity for existing shareholders. The direct listing model does not rely on shareholder or issuer lock-ups which prevent the sale or issue of shares for a period of time after the listing, and as such, shareholders are able to sell their shares immediately upon listing. Lock-ups are common in underwritten IPOs, where they tend to be structured as undertakings to the underwriting banks acting on the IPO and are intended to prevent an oversupply of shares in the market following the IPO.
• Equal access for all prospective investors and selling shareholders. In an underwritten IPO, participants tend to be limited to the issuer and shareholders on the sell-side and a subset of potential investors (most often institutional investors) on the buy-side, usually mediated or matched through meetings set up by the investment banks representing the issuer or selling shareholders. In contrast, the direct listing permits any shareholder to sell and any prospective investor to buy, by replacing the typical bookbuilding and price discovery process with price-setting purely by means of buy and sell orders received through broker-dealers by the stock exchange and establishment of an opening price by the exchange's designated market maker upon listing.
• Maximum transparency and market-driven price discovery. Rather than limiting investor engagement to group or one-on-one meetings during the customary IPO roadshow process, the direct listings employ investor days open to all interested parties who can participate via streaming services supplemented as needed with one-on-one meetings. In addition, the issuer can provide additional guidance, as it would do as a listed company, prior to the listing, so investors have a chance to consider the information before determining whether and at what price to invest.

In the case of Spotify and Slack, the transactions were innovative deals which have helped to define and develop the concept of direct listing in the United States. They involved a full registration and review process with the U.S. Securities and Exchange Commission and listing on the New York Stock Exchange, which subjects issuers to ongoing compliance with U.S. reporting requirements, among other things.

Moreover, the direct listings involved no primary issue of shares or secondary resale of shares alongside the listing, and so this particular structure requires that an issuer has no immediate need to raise capital.

How has the model been applied in the UK?

The U.S. model of direct listing is not the only possible application of the concept. Beyond spin-offs or pure secondary listings, introductions or direct listings can take different structures, as seen in the UK, for example:

• Diversified Gas & Oil (2020). Diversified Gas & Oil had been listed on AIM but undertook a transfer from AIM to a premium listing on the London Stock Exchange. Each year, a number of companies make the step-up from AIM to the Main Market of the London Stock Exchange, whether a standard listing or a premium listing. In the case of Diversified Gas & Oil, there was a corresponding placing (including a private placement to investors in the United States) and the company provided a 45-day lock-up in connection with the placing.
• Bank of Cyprus (2016). Bank of Cyprus sought a dual listing of a newly incorporated Irish holding company in London and Cyprus and simultaneous cancellation of its existing listings in Cyprus and Athens and obtained a standard listing on the London Stock Exchange. It provided no lock-ups in connection with its listing. Although a sponsor was not required at the time of listing, the Bank appointed an investment bank as an adviser in connection with the London listing, with a view to stepping up to a premium listing in due course (which has not yet occurred).
• Metro Bank (2016). The listing of Metro Bank was immediately preceded by a private placement, in which a number of investment banks participated as private placement advisers. The private placement amounted to 25% of the issued share capital of Metro Bank at admission to listing and helped to satisfy Metro Bank's free float requirement. The issuer entered into a 180-day lock-up with the private placement banks, and the directors 90-day lock-ups, in each case from the date of admission to listing.
• Caracal Energy (2013). The issuer, a Canadian corporation, undertook an admission to the premium listing segment. Although it had conducted private placements in the past, it had not conducted any private placements in the lead-up to or in connection with its listing. The issuer was subject to a 120-day lock-up issued to the sponsor. The admission prospectus also contained disclosure regarding the potential near- or medium-term sell-down of shares by certain shareholders of the issuer.
• Zenith Bank (2013). Zenith Bank obtained a standard listing of GDRs representing its shares, which were already listed in Nigeria. It pre-arranged with certain shareholders to convert their holdings into GDRs in order to satisfy free-float requirements in London. It did not enter into any lock-ups in connection with its listing in London.

In each of the cases above, there was no pre-listing research published, and there was no stabilisation activity, which is consistent with the approach adopted in the U.S. direct listings. Unlike the U.S. direct listings, some of the transactions involved lock-ups. It is also worth noting that these transactions were not intended to create the same level of publicity as the direct listings of Spotify and Slack, but greater publicity efforts could be put in place for such transactions, depending on the goals of the issuer and shareholders. For issuers with the right circumstances, a direct listing process akin to Spotify or Slack could be implemented in London as slight variations on the existing introduction structure. A key remaining question is what factors drive issuers toward a direct listing or a traditional IPO.

What are some considerations around whether to conduct a direct listing or a traditional IPO?

• Involvement of investment banks. In a traditional underwritten IPO, investment banks serve to assist issuers and selling shareholders in the execution of the IPO, including assistance with preparation of the prospectus and other investor materials, preparing independent connected research published at the time of the announcement of intention to float, setting up investor meetings and running the bookbuilding process for the IPO, as well as underwriting any settlement risk from pricing until closing. Although none of these roles is technically necessary in the case of a direct listing or other introduction transaction, in most of the examples, investment banks served other roles, such as financial adviser to assist with development of the equity story, execution and market-making, as private placement advisers for any fundraising concurrent with the listing, and as sponsor in the case of a premium listing.

• Production of research. Although not a feature of IPOs in the United States, pre-IPO connected and unconnected research is common, if not standard, for traditional underwritten IPOs in the UK and elsewhere in Europe. Research has not been a feature of any of the introductions in London, and issuers and their financial advisors would need to be mindful of compliance with the FCA's rules around provision of connected research in the event they intended to produce any in connection with a direct listing.

• Timing. Depending on the structure of the introduction or direct listing, the timetable could be dramatically shorter than a typical underwritten IPO, particularly when seeking a standard listing. A key difference between a direct listing and an IPO is the potential in a direct listing to stay private or avoid publicity for a longer period prior to listing: in an IPO, the issuer would need to go public at the time of publication of a registration document, which, in the absence of any other public statement, would tip the market off to an imminent event, where as in the case of a direct listing, if no research is to be produced, then no registration document is required, nor any announcement of an intention to float, and public announcement of the listing can be delayed until the publication of the prospectus shortly before admission occurs. Other timing considerations applicable to any transaction include the time necessary to prepare the prospectus and to obtain approval from the FCA, as well as production of any required information, such as historical financial information or competent person's reports for mineral companies. A longer timetable could be required for a premium listing than for a standard listing, to ensure sufficient time for preparation of the necessary comfort package for the sponsor.

• Investor base, free float requirements. The UK Listing Rules require a free float of at least 25% of the issued share capital. For FTSE index inclusion, this figure increases to 50% for non-UK-incorporated issuers. For issuers who already have a widely disbursed shareholder base, a direct listing could be an option; however, for issuers with a small shareholder base, a direct listing might not be possible absent derogations from the FCA's 25% free float requirement, as this is a condition of eligibility to list.

• Brand recognition, complexity of equity story. Even for issuers with a widely disbursed shareholder base, a strong brand recognition, including among retail investors, helps to support liquidity for shareholders and healthy trading. For issuers with less public brand recognition, particularly those whose equity stories might be more challenging to understand without further background, a programme of investor engagement might be required. Such investor engagement is a natural part of a traditional IPO, with early look meetings as well as the roadshow and pre-deal investor education, but has also featured in a more limited form in the latest direct listings in the United States.

• Form of price discovery. In a traditional underwritten IPO, price discovery is set through the bookbuilding process the underwriters lead. The underwriters work with the issuer and selling shareholders to achieve an optimal balance of value for the issuer and selling shareholders and for buyers, as well as seek to ensure adequate demand will exist in secondary trading to support the share price at or above the initial offer price. Investor feedback in the IPO process is also valuable for setting the price correctly and can highlight inflated or unrealistic valuations determined in prior private placement rounds, as was the case in WeWork's aborted IPO last year. However, generally in an IPO, only a limited portion of the share capital is being sold, and the remainder tends to be locked up in large measure, which can also have an impact on the price and liquidity of an issuer's shares. A direct listing as employed by Spotify and Slack theoretically permits all buyers and sellers (in the absence of any lock-ups) to arrive at an optimal price through their own buy and sell orders once trading commences on the stock exchange, although potentially without the customary discount initial investors receive in an underwritten IPO.

• Lock-ups and stabilisation to maintain an orderly market. In the case of the U.S. direct listings, there were no stabilisation activities or lock-ups; for the UK introductions, there has been no stabilisation, but practice on lock-ups has been varied. Stabilisation is not technically permitted in the case of a direct listing, since there is no offering to stabilise. The absence of lock-ups also means existing shareholders can sell immediately upon listing, which could impact share price dramatically if shareholders attempt to sell significant holdings immediately upon listing. This will depend in large measure on the shareholder composition prior to the listing, as the need for lock-ups arguably decreases the more dispersed the shareholder base.

• Capital requirements. Most direct listings do not involve a simultaneous fundraising and are instead typically employed by issuers who do not have any near-term capital fundraising requirements. However, in the case of Metro Bank, its listing was immediately preceded by a primary fundraise by means of private placement, and the structure of direct listings in the UK can be flexible and cater for a number of scenarios. In the event of any fundraising, there is a heightened risk of liability.

• Liability. Liability for an issuer and other participants in a direct listing is potentially more limited than in a traditional underwritten IPO, since the issuer is not selling any shares to investors, and the prospectus it prepares is used purely for purposes of obtaining the listing (or, in U.S. registered offerings, the registration for resales by existing shareholders). However, issuers and any financial advisers must consider potential liability in connection with any concurrent offering, such as a private placement which utilises an offering document, at the time of the direct listing or in close proximity to the listing. To the extent investment banks are involved in procuring purchasers for the offering including qualified institutional buyers in the United States, the banks will most likely require 10b-5 disclosure letters to be delivered by their counsel and issuer's counsel, which necessitates involvement of U.S. lawyers in the due diligence and prospectus drafting processes, to ensure compliance with U.S. standards.

Conclusion

The key features of the direct listing of Spotify and Slack in the United States set those transactions apart from other introductions which have occurred in London to date. Issuers can consider each of the features of those transactions—promoting liquidity, transparency and equal access for investors to participate in price discovery, all while engaging in the forms of publicity typically adopted in underwritten IPOs—against the features which have traditionally led issuers to adopt introductions in London, usually with much less publicity and market scrutiny, in order to determine whether one approach or the other, or a combination of the two, instead of a traditional underwritten IPO, could be appropriate as the next key step in the issuer's development.

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